Knight Said to Get Financing as Some Clients Shun Firm

Knight’s stock surged 27 percent to $3.30 as of 11:32 a.m. in New York after plunging 75 percent over the last two days. Photographer: Andrew Harrer/Bloomberg

Aug. 3 (Bloomberg) -- Knight Capital Group Inc., struggling
to stay afloat after a trading error spurred a $440 million loss
and caused some clients to trade elsewhere, told brokers it
secured short-term financing to fund market making, a person
with knowledge of the matter said.

The Jersey City, New Jersey-based securities firm has money
for today, according to the person, who requested anonymity
because the conversations were private. Knight’s stock surged 64
percent to $4.24 at 2:35 p.m. in New York, extending gains after
TD Ameritrade Holding Corp. said it will resume routing trades
to the firm. The shares had tumbled 75 percent in the previous
two sessions.

As the company opened its books to potential investors or
buyers, some of the world’s biggest investment firms and
electronic brokerages shunned the market maker for a third day.
The software bug on Aug. 1 flooded the market with unintended
trades and left Knight with a loss that threatens to exhaust its
cash. U.S. stock trades settle three days after they are made.

“Knight may or may not have the ability to withstand this
on a balance sheet basis, but their biggest risk is if people
decide not to do business with them,” Keith Wirtz, who oversees
$14.7 billion as chief investment officer for Fifth Third Asset
Management in Cincinnati, said in a telephone interview. Fifth
Third is a client of Knight’s. “In my 30-plus years experience,
your confidence with a counterparty like a Knight is only as
strong as their skills as well as their balance sheet.”

Books Open

Kara Fitzsimmons, a Knight spokeswoman, didn’t return a
call and e-mail requesting a comment today. The short-term
financing was reported earlier by the Wall Street Journal.

Knight opened its books to private-equity firms and at
least one securities-industry rival, said two people with
knowledge of the matter. It’s working with Sandler O’Neill &
Partners LP and Goldman Sachs Group Inc. as advisers in the
rescue talks, said one of the people, who spoke on condition of
anonymity because the discussions are private. The company is
under pressure to strike a deal within days, the people said.

The trading fault, which caused stocks to move as much as
151 percent, left the firm with a “large error position,”
Knight Chief Executive Officer Thomas Joyce told Bloomberg
Television yesterday.

‘Capable People’

“We’re talking to a lot of capable people, people who are
in touch with situations like this,” Joyce said yesterday.
“This was an anomaly, not one we’re proud of.” Joyce declined
to elaborate on the discussions during the interview, saying
“you might imagine during the day-to-day activity, it’s kind of
hard to comment.”

John Woerth, of Vanguard Group Inc., and Whitney Ellis, a
spokesman for Scottrade Inc., said in e-mails that their firms
continue to avoid routing brokerage orders through Knight.
Fidelity Investments, the second-largest mutual-fund company, is
routing orders away from Knight, according to a person familiar
with the matter, who asked not to be identified because the
information is private.

TD Ameritrade Holding said it will resume routing client
trades to Knight after testing its systems.

“After considerable review and discussion, we are resuming
our order routing relationship with Knight,” said Fred Tomczyk,
president and chief executive officer at TD Ameritrade, in a
statement. “Knight is one of many order routing destinations for
us and has long been a good and trusted partner.”

Market Routing

About 23 percent of Vanguard’s market orders in NYSE-listed
securities were routed to Knight last quarter, according to a
filing. The figure was 41 percent at Scottrade, 38 percent at
Fidelity’s National Financial Services LLC unit and 9 percent at
TD Ameritrade.

Fitch Ratings said in a statement that it does not expect
any major counterparties of Knight to suffer large losses even
in a bankruptcy scenario since “numerous institutions” have
already switched to other market makers. The issue still may
lead to a structural change in the business, the ratings firm
said.

“The events of the last two days again pose risks for
equity trading volume as many investors become more concerned
about seemingly unforeseeable risks related to trading
technology problems and the broader market impact of high-frequency trading systems that periodically break down,” Fitch
said in the statement.

Slowing Volume

The number of exchange-listed securities changing hands on
average each day fell 11 percent to 6.12 billion in July from a
year ago, according to data compiled by Bloomberg.

Knight’s $440 million loss compares with net income of
$115.2 million in 2011 and is more than the company’s market
value of $253 million at the close yesterday, data compiled by
Bloomberg show. The company was worth as much as $4.8 billion in
2000 and valued at more than $1 billion before yesterday,
according to data compiled by Bloomberg.

The loss represents about 40 percent of Knight’s book value
and would “exhaust” the firm’s cash, according to CLSA Credit
Agricole Securities. Knight had $365 million of cash as of the
end of June, with about $70 million in its revolving credit
line, Robert Rutschow, a New York-based analyst with CLSA, wrote
in a report yesterday.

Kenneth Pasternak, who co-founded Knight in 1995 and
retired in 2002, said in a telephone interview that a takeover
by a big bank may slow the process of innovation that helped
Knight become a leader in computerized trading.

‘CYA Behavior’

“I seriously doubt they will go out of business,” said
Pasternak, who now runs a family office, Chestnut Ridge Capital
LLC, in Jersey City. “I just hope they can maintain the
innovation. My fear is they will be bought by some big bank and
become consumed by the CYA behavior and lose their edge.”

Knight’s market-making unit executed a daily average of
$19.5 billion worth of equities in June, according to its
website. The unit traded 711 million exchange-listed shares a
day in June, according to data compiled by the company and
Bloomberg.

The NYSE reviewed trading in 140 stocks from Molycorp Inc.
to AT&T Inc. as the market’s Aug. 1 open was disrupted. Trades
that occurred during the height of the volatility were canceled
in six securities, where prices swung at least 30 percent in the
first 45 minutes. Trades in all of the other stocks were allowed
to stand.

‘Technology Breaks’

“Technology breaks,” Joyce told Bloomberg TV yesterday.
“It ain’t good. We don’t look forward to it.” He added that
the problem is mainly one for his firm, and “we did not harm
individual investors, we got them out of the way.”

The software malfunction was the latest black eye for the
computer infrastructure of an equity market still haunted by the
May 2010 market crash, the botched initial public offering of
Facebook Inc. and failed IPO of Bats Global Markets Inc.

The Securities and Exchange Commission has been monitoring
the situation, spokesman Kevin Callahan said in an e-mail
yesterday. George Smaragdis, spokesman for the Financial
Industry Regulatory Authority, said Finra has examiners on site
and is working with Knight and other regulators to review the
impact of the incident.

The error has fueled scrutiny that may reshape an industry
spread across about 50 trading venues. The head of the New York
Stock Exchange said the firm’s crisis is a “call to action” to
fix a market that’s grown too complex to explain to regulators.

“The structure that has evolved over the last decade in
the U.S. has led to inexorable fragmentation, really an emphasis
on speed, a feeling that if something is faster than by
definition it’s better,” NYSE Euronext Chief Executive Officer
Duncan Niederauer said during a conference call today after the
company reported earnings. “We are understanding that speed is
not always better.”